On December 12, 2011, the SEC announced an enforcement proceeding that serves as a useful reminder that the federal laws against insider trading and misrepresentation apply as forcefully to private companies purchasing stock from employees and other shareholders as they do in the public company setting. In SEC v. Stiefel Laboratories Inc.,1 the SEC alleges that Stiefel and its CEO, Charles W. Stiefel, violated Rule 10b-5, and defrauded shareholders by over $110 million, by buying stock from employees at prices that did not reflect the per share prices implied by acquisition offers that Stiefel was receiving from third parties. The SEC alleges a number of other violations, including making misrepresentations to shareholders about the process used to sell the company and failing to update third party evaluations – all for the purpose of increasing the percentage of shares held by the Stiefel family at the time the sale took place. The case applies the basic holding of the Texas Gulf Sulphur2 case that companies must “disclose or abstain from trading” when buying shares from shareholders. The SEC seeks to bar Stiefel’s CEO from serving as a director or executive officer of a public company, and seeks permanent injunctive relief, financial penalties and the disgorgement of ill-gotten gains from both defendants.
The SEC’s allegations paint a picture of duplicity and self-dealing by Stiefel and its CEO. Stiefel told its employee shareholders that stock purchases would be at “current market value,” yet its valuations were revised only once a year. The Plan documents stated that the stock’s fair market value would be determined “from time to time as may be necessary for any purpose under the Plan. …” [Complaint at 18]. The SEC argued that the valuations were therefore misleading. [Complaint at 16]. Perhaps more importantly, the SEC stated that the valuations were misleading because they failed to reflect or disclose higher valuations by third parties. For example, Stiefel’s valuations did not reflect that in November 2006 five prominent private equity firms offered to buy preferred stock at 50 percent to 200 percent over prevailing valuations [Complaint at 7] or that in August 2007 a private equity firm invested $500 million in Stiefel at an equity valuation that was more than 300 percent higher than the valuation Stiefel was using for its stock purchases from employees. [Complaint at 17]. Moreover, Stiefel did not disclose these valuations to its employee shareholders.
Allegations of self-dealing run through the Complaint. Stiefel used its own cash to increase its purchases in 2008 and 2009, apparently to maximize the Stiefel family’s ownership at the time of sale, even though Stiefel was in financial distress and was at risk of violating its debt covenants. Moreover, apparently to increase the number of shares available for purchase, Stiefel amended its employee stock plan to allow company purchases from current employees, not just from employees who had retired or otherwise departed from Stiefel, and then scheduled presentations that “touted the benefits of diversification to employee shareholders.” The Complaint noted that an email sent on February 14, 2009, from one Stiefel family member to another exclaimed: “because of the share buybacks from employee shareholders, ‘it is nice to see the $ go up for all of us!’” [Complaint at 13].
In addition, the SEC contends that Stiefel executives plotted to mislead their shareholders. On January 20, 2009, Stiefel cancelled an employee meeting because executives feared some “might ask how determined the company was to remain private.” [Complaint at 12]. On February 5, 2009, after the Company had signed confidentiality agreements regarding a prospective sale with two bidders (including GlaxoSmithKline, the eventual acquirer), Stiefel emailed senior executives that, if any employee asked about acquisition rumors, the executives should say “companies had been expressing interest…acquiring [Stiefel] for decades; Stiefel liked being private and independent; and … in 162 years no one had made an offer the family had wanted to accept.” [Complaint at 13]. Even worse, on February 13, Todd Stiefel, the company’s chief strategy officer, emailed senior management to say that, in response to questions about a potential sale, they should “blow it off as if it not an issue or as if it is plain silly” and if necessary “flatly deny it.” [Complaint at 13].
This case serves as a powerful reminder that:
- The insider trading laws apply to private companies as well as to public companies, and to transactions with employees and employee stock plans as well as with third-party shareholders. Moreover, this case emphasizes that the SEC will prosecute cases involving private companies and employee shareholders.
- The SEC believes that valuations used as a basis for buying shares from employees should be current as of the date of purchase when companies tell their shareholders that purchases will be made at current “fair market value.”
- Family-owned companies should beware of behavior that could suggest that the family is using its control position to increase its ownership percentage at the expense of employees and other shareholders.
- If you hire an advisor to provide a third-party valuation as to a company’s fair market value, ensure that the advisor receives all material information, particularly information about offers received from third parties for the purchase of the company or its shares. Make sure that the advisor is well-qualified and well-informed. The SEC stated that the accountant selected by Stiefel was not qualified to evaluate the fair market value of the company and did not receive material information such as the third-party valuations. [Complaint at 6].
- Companies generally should pay the same amount to all shareholders from whom shares are purchased at about the same time, unless specific factors require otherwise. Differences in payments can give rise to the argument that the shareholder receiving the lower amount was treated unfairly.
- If a company does not wish to address acquisition rumors, the correct response is to refuse to comment. Companies should not do what the defendants allegedly did in Stiefel—prepare “talking points” to mislead investors and divert them from what is really happening.
- Make sure the documents of employee stock plans are truthful in all material respects. In Stiefel, for example, SEC alleged that the employee documents discussed the stock valuation procedure, but failed to disclose that the resulting valuation would be reduced by 35 percent.
- Family-owned companies, and especially those having family members in key management positions, may wish to consider allowing committees of independent directors or outside counsel to review key aspects of the decision to buy shares from minority shareholders, such as the materiality of acquisition discussions and whether valuations should be updated.